Management buyout (MBO): Succession from within

When looking for a successor, owners usually look first to family members or external buyers. Sometimes, however, the right candidate is already in the business. In a management buyout, members of the management team take over the business they have helped shape for years. They know its operations, customers and employees, and have earned their trust.

This means comparatively little changes for employees and business partners, while the owner knows the business is in familiar hands. To ensure the transition also works economically, legally and for tax purposes, several key decisions must be made at an early stage.

Financing often combines several components

Money is usually the biggest hurdle. Management teams rarely have enough equity to acquire a business using their own resources. The purchase price therefore often comprises several components:

• Equity demonstrates to the banks that management is putting its own capital at risk.
• Bank loans are often supplemented by programs from development finance institutions such as LfA Förderbank Bayern or KfW.
• In some cases, financial investors also provide the missing equity and receive shares in return.
• The seller often defers part of the purchase price as a vendor loan and receives payment in installments.

Banks view a vendor loan as a strong signal because the former owner remains economically invested in the successor’s success. The seller also assumes its own risk, however: banks regularly require their loan to be serviced first. The vendor loan agreement should therefore address ranking, security and payment terms.

Acquisition vehicle, tax group and interest deductions

In many cases, the managers establish their own acquisition vehicle (NewCo) when acquiring a GmbH, and NewCo raises the acquisition financing. A tax group (Organschaft) can allow interest to be offset for tax purposes against the operating company’s profits. Among other requirements, the acquisition vehicle must hold a majority of the voting rights from the beginning of the financial year, and the parties must enter into and actually implement a profit and loss transfer agreement for at least five years (Section 14 of the German Corporate Income Tax Act (KStG)).

A defensible business valuation that both sides can rely on builds trust. It helps avoid the impression that one side has taken advantage of the other. At this stage, the legal agenda also includes confidentiality, non-compete obligations and amendments to existing managing director and employment agreements.

Tax consequences for the seller

How much of the purchase price the seller ultimately retains depends largely on the legal form and transaction structure. A sole proprietorship is sold by transferring its business assets. For partnerships and GmbHs, the key question is whether the transaction transfers equity interests or individual assets.

• Business, division or co-entrepreneur interest: If the seller is at least 55 years old or permanently unable to work, the seller may claim a EUR 45,000 allowance once in a lifetime (Section 16(4) EStG). The allowance is reduced to the extent the capital gain exceeds EUR 136,000. Under the same conditions, the seller may also claim the reduced tax rate under Section 34(3) EStG, likewise once in a lifetime. The age threshold must have been reached at the time of the sale.
• GmbH shares held as private assets: For a shareholding of at least 1%, the gain is subject to the partial-income method under Section 17 EStG. The allowance and reduced tax rate under Sections 16 and 34 EStG do not apply.

From employee to entrepreneur

An MBO changes more than ownership. It also changes the parties’ roles. A sales director or authorized signatory (Prokurist) becomes an entrepreneur responsible for loans and jobs. Many owners continue to support the transition for a period, for example as advisers or members of the advisory board. This gives the successor support and provides customers and banks with additional comfort.

Starting the process on the right footing

Many MBOs never progress beyond friendly preliminary discussions. The parties reach an early understanding but never discuss price. A more effective starting point is:

• The parties should put their purchase price expectations on the table in the first discussions.
• The prospective buyers should present the seller with a proposal covering the purchase price, financing and timetable.
• The parties should agree a Letter of Intent (LOI) that records the key terms, addresses exclusivity and binding effect, and gives both sides certainty before they invest time and money in valuation, financing and definitive documentation.

Key takeaways

A management buyout can provide a viable succession solution if financing, structure and valuation are planned early and in coordination. The process should be binding and begin with clear numbers, while addressing legal and tax issues jointly from the outset.